Answer:
Options:
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The bond-yield-plus-risk-premium approach to estimating the cost of common equity involves adding a risk premium to the interest rate on the company’s own long-term bonds. The size of the risk premium for bonds with different ratings is published daily in The Wall Street Journal or is available online.
b. The WACC is calculated using a before-tax cost for debt that is equal to the interest rate that must be paid on new debt, along with the after-tax costs for common stock and for preferred stock if it is used.
c. An increase in the risk-free rate is likely to reduce the marginal costs of both debt and equity.
d. The relevant WACC can change depending on the amount of funds a firm raises during a given year. Moreover, the WACC at each level of funds raised is a weighted average of the marginal costs of each capital component, with the weights based on the firm’s target capital structure.
e. Beta measures market risk, which is generally the most relevant risk measure for a publicly-owned firm that seeks to maximize its intrinsic value. However, this is not true unless all of the firm’s stockholders are well diversified.
Answer:
Options:
Question: Which of the following statements is CORRECT?
Answer Choices:
a. In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project’s cash flows will lead to an upward bias in the NPV.
b. In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project’s cash flows will lead to a downward bias in the NPV.
c. The existence of any type of “externality” will reduce the calculated NPV versus the NPV that would exist without the externality.
d. If one of the assets to be used by a potential project is already owned by the firm, and if that asset could be sold or leased to another firm if the new project were not undertaken, then the net proceeds that could be obtained should be charged as a cost to the project under consideration.
e. If one of the assets to be used by a potential project is already owned by the firm but is not being used, then any costs associated with that asset is a sunk cost and should be ignored.
Answer:
d. If one of the assets to be used by a potential project is already owned by the firm, and if that asset could be sold or leased to another firm if the new project were not undertaken, then the net proceeds that could be obtained should be charged as a cost to the project under consideration.
Question: The full amount of a lease payment is tax deductible provided the contract qualifies as a true lease under IRS guidelines.
Answer:
Options:
Question: Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and bondholders?
Answer Choices:
a. Including restrictive covenants in the company’s bond indenture (which is the contract between the company and its bondholders).
b. Compensating managers with more stock options and less cash income.
c. The passage of laws that make it harder for hostile takeovers to succeed.
d. A government regulation that banned the use of convertible bonds.
e. The firm begins to use only long-term debt, e.g., debt that matures in 30 years or more, rather than debt that matures in less than one year.
Answer:
a
Question: A warrant holder is not entitled to vote, but he or she does receive any cash dividends paid on the underlying stock.
Answer:
Options:
Question: Preferred stock can provide a financing alternative for some firms when market conditions are such that they cannot issue either pure debt or common stock at any reasonable cost.
Answer:
Options:
Question: A sale and leaseback arrangement is a type of financial, or capital, lease.
Answer:
Options:
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The component cost of preferred stock is expressed as rₚ(1 − T). This follows because preferred stock dividends are treated as fixed charges, and as such they can be deducted by the issuer for tax purposes.
b. A cost should be assigned to retained earnings due to the opportunity cost principle, which refers to the fact that the firm’s stockholders would themselves expect to earn a return on earnings that were paid out rather than reinvested.
Answer:
Options:
Question: Which of the following statements is CORRECT?
Answer Choices:
a. When calculating the cost of preferred stock, a company needs to adjust for taxes, because preferred stock dividends are deductible by the paying corporation.
b. All else equal, an increase in a company’s stock price will increase its marginal cost of retained earnings, rₛ.
c. All else equal, an increase in a company’s stock price will increase its marginal cost of new common equity, rₑ.
d. Since the money is readily available, the after-tax cost of retained earnings is usually much lower than the after-tax cost of debt.
e. If a company’s tax rate increases but the YTM on its noncallable bonds remains the same, the after-tax cost of its debt will fall.
Answer:
Options:
Question: Operating leases help to shift the risk of obsolescence from the user to the lessor.
Answer:
Options:
Question: Leasing is often referred to as off-balance-sheet financing because lease payments are shown as operating expenses on a firm’s income statement and, under certain conditions, leased assets and associated liabilities do not appear on the firm’s balance sheet.
Answer:
Options:
Question: From the lessee viewpoint, the riskiness of the cash flows, with the possible exception of the residual value, is about the same for a lease as it is for a purchase.
Answer:
Options:
Question: Unlike bonds, the cost of preferred stock to the issuing firm is the same on a before-tax and after-tax basis. This is because dividends on preferred stock are not tax deductible, whereas interest on bonds is deductible.
Answer:
Options:
Question: Preferred stock normally has no voting rights. However, most preferred issues stipulate that the preferred stockholders can elect a minority number of the directors if the preferred dividend is omitted.
Answer:
Options:
Question: Which of the following statements is CORRECT?
Answer Choices:
a. When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation.
b. When calculating the cost of preferred stock, companies must adjust for taxes, because dividends paid on preferred stock are deductible by the paying corporation.
c. Because of tax effects, an increase in the risk-free rate will have a greater effect on the after-tax cost of debt than on the cost of common stock as measured by the CAPM.
d. If a company’s beta increases, this will increase the cost of equity used to calculate the WACC, but only if the company does not have enough retained earnings to take care of its equity financing and hence must issue new stock.
Answer:
Options:
Question: The more conservative a firm’s management is, the higher its total debt to total capital ratio (measured as Short-term debt + Long-term debt Debt + Preferred stock + Common equity Debt + Preferred stock + Common equity Short-term debt + Long-term debt is likely to be.
Answer Choices:
a. True
b. False
Answer:
b. False
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The WACC is calculated using before-tax costs for all components.
b. The after-tax cost of debt usually exceeds the after-tax cost of equity.
c. For a given firm, the after-tax cost of debt is always more expensive than the after-tax cost of non-convertible preferred stock.
d. Retained earnings that were generated in the past and are reported on the firm’s balance sheet are available to finance the firm’s capital budget during the coming year.
e. The WACC that should be used in capital budgeting is the firm’s marginal, after-tax cost of capital.
Answer:
Options:
Question: Other things held constant, the higher a firm’s total debt to total capital ratio (measured as Short-term debt + Long-term debt Debt + Preferred stock + common equity Debt + Preferred stock + common equity Short-term debt + Long-term debt ), the higher its TIE ratio will be.
Answer Choices:
a. True
b. False
Answer:
b. False
Question: Preferred stock is a hybrid—a sort of cross between a common stock and a bond—in the sense that it pays dividends that normally increase annually like a stock but its payments are contractually guaranteed like interest on a bond.
Answer Choices:
a. True
b. False
Answer:
b. False
Question: For capital budgeting and cost of capital purposes, the firm should assume that each dollar of capital is obtained in accordance with its target capital structure, which for many firms means partly as debt, partly as preferred stock, and partly common equity.
Answer Choices:
a. True
b. False
Answer:
a. True